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GDP and life satisfaction: New evidence
Eugenio Proto, Aldo Rustichini, 11 January 2014
The link between higher national income and higher national life satisfaction is critical to economic
policymaking. This column presents new evidence that the connection is hump-shaped. There is a clear,
positive relation in the poorer nations and regions, but it flattens out at around $30,000–$35,000, and then
turns negative.
A
A
175
A commission on the measurement of economic
performance and social progress was created on the
French government’s initiative. Since 2008, this
distinguished group of social scientists has put
subjective well-being into the limelight as a possible
supplement to traditional measures of development
such as GDP (Stiglitz et al. 2009). The British
government has also shown considerable interest in
developing a subjective well-being measure in recent
years as an instrument for policy.
Eugenio Proto
Associate Professor, Warwick
University
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Income, GDP, and life satisfaction
Aldo Rustichini
Professor, Department of
Economics, University of
Minnesota
The debate on the link between income, or GDP, and life satisfaction is still open.
• On one hand, Easterlin (1974) reported no significant relationship between happiness and
aggregate income in time-series analysis.
For example, Easterlin shows that US income per capita during the period 1974–2004 almost
doubled, but the average level of happiness showed no appreciable upward trend. This puzzling
finding, appropriately called the Easterlin Paradox, has been confirmed in similar studies by
psychologists (Diener et al. 1995) and political scientists (Inglehart 1990), and has been confirmed
for European countries (Easterlin 1995).1
• On the other hand, life satisfaction appears to be strictly monotonically increasing with income
when one studies this relation at a point in time across nations (Inglehart 1990, Deaton 2008,
Stevenson and Wolfers 2008).
To reconcile the cross-sectional evidence with the Easterlin Paradox, some have suggested that the
positive relation in happiness vanishes beyond some value of income (Layard 2005, Inglehart 1990,
Inglehart et al. 2008, Di Tella et al. 2010). This last interpretation has been questioned by Deaton
(2008) and Stevenson and Wolfers (2008), who claim that there is a positive relation between GDP
and life satisfaction in developed countries. From the opposite perspective, it is being questioned by
Easterlin et al. (2010), who provide some evidence that there is no long-run effect even for
developing countries.
The complexity of the income–life satisfaction relation
To start from the evidence:
• It is known that life satisfaction is increasing in personal income at a decreasing rate (e.g.
Blanchflower and Oswald 2004, Layard et al. 2008, Kahneman and Deaton 2010).
However, the relationship is complicated by the existence of other effects acting with an opposite
sign:2
• People’s aspirations adapt to the new situation, an idea originally proposed by Brickman and
Campbell (1971).3
http://www.voxeu.org/article/gdp-and-life-satisfaction-new-evidence
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11.02.2014
GDP and life satisfaction: New evidence | vox
• The effect of relative income on individual life satisfaction – the so-called ‘Keeping up with the
Joneses’ hypothesis – an idea that dates back to Duesenberry (1949).4
Recently, Benjamin et al. (2012) show that maximising an individual’s utility might not always
coincide with maximising life satisfaction. This opens the theoretical possibility that, in equilibrium,
lower levels of income might correspond to higher levels of life satisfaction.
Reassessing the relationship
Our recent work differs from the previous literature in that we undertake the analysis without
imposing a particular functional form on the econometric model (Proto and Rustichini 2013).
Specifically, we partition all individual observations into quantiles of per capita GDP by the country
of residence (with the first quantile of the distribution containing the individuals living in the poorest
countries), and then we estimate the relation between GDP and happiness by using the quantiles.
The second important methodological feature of our analysis is the introduction of a country-specific
effect, to control for time-invariant country-specific unobservable variables. This eliminates potential
sources of country-specific measurement error and omitted-variable bias. This control is possible
thanks to the panel structure of the World Values Survey dataset. The introduction of this control is
of crucial importance for analysis based on survey data, because the questionnaires are generally
different across countries, and there are pervasive effects due to culture and language on the
statement made in the surveys. Many measurement errors in indices of life satisfaction are possible.
For example, a well-known error is due to differential item functioning, defined as the interpersonal
and intercultural variation in interpreting and using the response categories for the same question.
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A systematic measurement error in the life satisfaction reports lead to either a positive or negative
bias, depending on the correlation between the measurement error and other variables in the
regression. For example, an over-report of life satisfaction, in Western countries, could generate a
positive bias in cross-country estimates of the impact of income on life satisfaction. Omitted-variable
bias could be equally problematic. If cultural elements determine a time-invariant preference for
public good supply in some country, or if income distribution – usually very persistent – is correlated
with both life satisfaction and GDP, this would result in a bias in the relation between GDP and life
satisfaction. Controlling for country-specific effects eliminates all biases that could be generated by
the time-invariant unobservable variables mentioned in the examples.
Main findings
Figure 1 summarises the main findings of the analysis.
Figure 1 Relationship between GDP per capita and life satisfaction
Note: Each point represents the coefficient of an ordered probit regression of life satisfaction on all individuals in the
World Values Survey (for the waves 1981–84, 1989–93, 1994–99, 1999–2004, 2005–08) grouped in 50 different
quantiles according to the per capita GDP of the country they live in.
• Most of the variation of life satisfaction due to GDP is explained by the effect in countries with
per capita GDP below $10,000 (data are PPP-adjusted).
People in countries with a GDP per capita of below $6,700 were 12% less likely to report the
highest level of life satisfaction than those in countries with a GDP per capita of around $20,000.
http://www.voxeu.org/article/gdp-and-life-satisfaction-new-evidence
11.02.2014
GDP and life satisfaction: New evidence | vox
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• Countries with GDP per capita over $20,000 see a much less obvious link between GDP and
happiness.
Between this level and the very highest GDP per capita level ($54,000), the probability of reporting
the highest level of life satisfaction changes by no more than 2%, and seems to be hump-shaped,
with a bliss point at around $33,000. This corresponds broadly to the well-known Easterlin Paradox
– that the link between life satisfaction and GDP is more or less flat in richer countries.
To further assess the importance of taking into account the unobserved heterogeneity, we perform a
second analysis of the relationship between aggregate income and life satisfaction on more
homogeneous territorial units. We restrict the sample to all countries within the EU before the first
enlargement to eliminate potentially confounding factors at the country level; Figure 2 show the
main findings of this second analysis. This confirms the findings of the country-based analysis
outlined above.
Figure 2 Relationship between regional GDP and life satisfaction in Europe
Note: Each point represents the European Region (following the NUTS 2 nomenclature) before the first enlargement,
weighted for the population. Life satisfaction data are from the European Values Survey. Data for regional GDP are from
Eurostat; they are PPP-adjusted at the country level.
• Data show a clearly positive relation between aggregate income and life satisfaction in the
poorer regions, but this relation flattens and appears to turn negative for richer regions, with a
bliss point between $30,000 and $33,000.
An explanation for the bliss point
If, following the above-mentioned literature, the relation between GDP and life satisfaction is the
result of combined effects of aspirations to increase personal income, or an increasing target in
terms of income comparison, then the net effect on life satisfaction is not necessarily monotonic. In
Proto and Rustichini (2012), we provide a micro-founded model, where income is endogenous and
increases with aspirations. If the probability of fulfilling aspirations is decreasing in aspirations, this
can generate a negative effect on life satisfaction that can counterbalance the positive direct effect
of the income.
We test this hypothesis using the European data, and find the usual positive effect due to personal
income and a negative effect due to the negative distance between personal income and regional
GDP. We argue that this second effect can be related to the negative effect induced by the distance
from the target income. We use modern personality theory to test the hypothesis, predicting that this
effect should be higher for more neurotic individuals, naturally more averse to losses. We find
support in the data for this explanation.
Conclusions
http://www.voxeu.org/article/gdp-and-life-satisfaction-new-evidence
11.02.2014
GDP and life satisfaction: New evidence | vox
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Our econometric analysis implies that long-term GDP growth is certainly desirable among poorer
countries, but is it a desirable feature among developed countries as well? Recent evidence shows
the negative effect of high aspiration can also be rationally predicted by individuals who,
nevertheless, may still choose options that may not seem to maximise happiness, but which are
compatible with high-income aspirations.
This implies that individuals may still prefer to live in richer countries, even if this would result in a
decreased level of life satisfaction. In other words, the fact that individuals aspire to a higher income
may not be considered – from an individual perspective – a negative feature of an economy even if
this might result in a lower level of reported life satisfaction among the richest countries.
References
Benjamin, D J, O Heffetz, M S Kimball, and A Rees-Jones (2012), “What Do You Think Would Make
You Happier? What Do You Think You Would Choose?”, American Economic Review, 102(5): 2083
–2110.
Blanchflower, D G and A J Oswald (2004), “Well-Being over Time in Britain and the USA”, Journal
of Public Economics, 88: 1359–1386.
Brickman, P D and D T Campbell (1971), “Hedonic relativism and planning the good society”, in M
H Appley (ed.), Adaptation-Level Theory: A Symposium, New York: Academic Press: 287–302.
Clark, A E, P Frijters, and M A Shields (2008), “Relative Income, Happiness, and Utility: An
Explanation for the Easterlin Paradox and Other Puzzles”, Journal of Economic Literature, 46(1): 95
–144.
Clark, A E and A J Oswald (1996), “Satisfaction and Comparison Income”, Journal of Public
Economics, 61: 359–381.
Clark, L A and D Watson (2008), “Temperament: An Organizing Paradigm for Trait Psychology”, in
O P John, R W Robins, and L A Pervin (eds), Handbook of personality: Theory and research, New
York: Guilford Press: 265–286.
Deaton, A (2008), “Income, Health and Well-Being around the World: Evidence from the Gallup
World Poll”, Journal of Economic Perspectives, 22: 53–72.
Diener, E, M Diener, and C Diener (1995), “Factors Predicting the Subjective Well-Being of
Nations”, Journal of Personality and Social Psychology, 69: 851–864.
Di Tella, R and R MacCulloch (2010), “Happiness Adaptation to Income Beyond ‘Basic Needs’”, in E
Diener, J Helliwell, and D Kahneman (eds), International Differences in Well-Being, Oxford: Oxford
University Press.
Duesenberry, J S (1949), Income, Saving, and the Theory of Consumer Behavior, Cambridge and
London: Harvard University Press.
Easterlin, R A (1974), “Does Economic Growth Improve the Human Lot? Some Empirical Evidence”,
in R David and M Reder (eds), Nations and Households in Economic Growth: Essays in Honor of
Moses Abramovitz, New York: Academic Press: 89–125.
Easterlin, R A (1995), “Will Raising the Incomes of All Increase the Happiness of All?”, Journal of
Economic Behavior and Organization, 27: 35–47.
Easterlin, R A (2005), “Feeding the Illusion of Growth and Happiness: A Reply to Hagerty and
Veenhoven”, Social Indicators Research, 74: 429–443.
Easterlin, R A (2005), “A Puzzle for Adaptive Theory”, Journal of Economic Behavior and
Organization, 56(4): 513–521.
Easterlin, R A, L A McVey, M Switek, O Sawangfa, and J S Zweig (2010). “The Happiness-Income
Paradox Revisited”, Proceedings of the National Academy of Sciences, 107(52): 22463–22468.
Ferrer-i-Carbonell, A (2005), “Income and well-being: an empirical analysis of the comparison
income effect”, Journal of Public Economics, 89: 997–1019.
Inglehart, R (1990), Cultural Shift in Advanced Industrial Society, Princeton: Princeton University
Press.
Inglehart, R, R Foa, C Peterson, and C Welzel (2008), “Development, Freedom, and Rising
Happiness: A Global Perspective (1981–2007)”, Perspectives on Psychological Science, 3: 264–
285.
http://www.voxeu.org/article/gdp-and-life-satisfaction-new-evidence
11.02.2014
GDP and life satisfaction: New evidence | vox
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Kahneman, D and A Deaton (2010), “High Income Improves Evaluation of Life but not Emotional
Well-Being”, Proceedings of the National Academy of Sciences, 107: 16489–16493.
Layard, R (2005), Happiness: Lessons from a New Science, London: Penguin.
Layard, R, G Mayraz, and S Nickell (2008), “The Marginal Utility of Income”, Journal of Public
Economics, 92(8–9), 1846–1857.
Luttmer, E (2005), “Neighbors as Negatives: Relative Earnings and Well-Being”, Quarterly Journal
of Economics, 120(3): 963–1002.
McBride, M (2010), “Money, Happiness, and Aspiration Formation: An Experimental Study”, Journal
of Economic Behavior and Organization, 74(3): 262–276.
Oswald, A (1997), “Happiness and Economic Performance”, Economic Journal, 107: 1815–1831.
Proto, E and A Rustichini (2012), “Life Satisfaction, Household Income and Personality Traits”, The
Warwick Economics Research Paper Series (TWERPS) 988.
Proto E and A Rustichini (2013), “A Reassessment of the Relationship between GDP and Life
Satisfaction”, PLoS ONE, 8(11): e79358.
Senik, C (2009), “Direct Evidence on Income Comparison and their Welfare Effects”, Journal of
Economic Behavior and Organization, 72: 408–424.
Stevenson, B and J Wolfers (2008), “Economic Growth and Subjective Well-Being: Reassessing the
Easterlin Paradox”, Brookings Papers on Economic Activity, 1: 1–87.
Stiglitz, J E, A Sen, and J-P Fitoussi (2009), “Report of the commission on the measurement of
economic performance and social progress”, CMEPSP. http://www.stiglitz-sen-fitoussi.fr
Stutzer, A (2004), “The Role of Income Aspirations in Individual Happiness”, Journal of Economic
Behavior and Organization, 54(1): 89–109.
1 There is some disagreement on the conclusion when an analysis based on time-series is used.
Oswald (1997) shows evidence of a small positive temporal correlation between life satisfaction and
GDP in industrialised countries, and Stevenson and Wolfers (2008) find significant happiness gains
in Japan in the post-war period.
2 On the considerable literature that examines the complicating factors, see Clark et al. 2008 for an
extensive survey.
3 Easterlin (2005), Stutzer (2004), and McBride (2010) provide some empirical evidence on how
aspirations increase in income.
4 Clark and Oswald (1996), Blanchflower and Oswald (2004), Luttmer (2005), Ferrer-i-Carbonell
(2005), and Senik (2009) among others present empirical validations of this hypothesis.
175
Topics: Development, Frontiers of economic research
Tags: development, Easterlin paradox, growth, happiness, national income, subjective well-being
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